Balance Sheet & Liquidity Risk

Balance sheet risk management is about managing interest rate, and liquidity risks that arise out of the Group’s core banking activities.

The Asset & Liability Committee (“ALCO”), under delegated authority from the Board, approves policies, strategies and limits for the management of structural balance sheet risk exposures. These are monitored by BSRM. ALCO’s decisions and its risk management reports are reviewed by the Board Risk Management Committee (“BRMC”).

In the course of its core banking activities, the Group strives to meet customers’ demands and preferences for products with various interest rate structures and maturities. Mismatches in repricing and other characteristics of assets and liabilities give rise to sensitivity to interest rate movements. As interest rates and yield curves change over time, these mismatches may result in a decline in earnings. The primary objective in managing balance sheet risk, therefore, is to manage the volatility in net interest income (“NII”) and economic value of equity (“EVE”). EVE is the present value of the Group’s assets less the present value of the Group’s liabilities.

Balance sheet interest rate risk exposure is quantified using a combination of static analysis tools and dynamic simulation techniques. Static analysis tools such as repricing schedules and sensitivity analysis provide indications of the potential impact of interest rate changes on interest income and price value through the analysis of the sensitivity of assets and liabilities to changes in interest rates. Interest rate sensitivity varies with different repricing periods, currency and embedded optionality. Mismatches in the longer tenor will experience greater change in the price-value of interest rate positions than similar positions in the shorter tenor.

In the dynamic simulation process, the Group applies both the earnings and EVE approaches to assess interest rate risk. The potential effects of interest rate change on NII are estimated by simulating the possible future course of interest rates, expected changes in the Group’s business activities over time, as well as the effects of embedded options. Embedded options may be in the form of loan prepayment and deposit pre-upliftment. Changes in interest rates are simulated using different interest rate scenarios such as changes in the shape of the yield curve, including high and low rates, positive and negative tilt scenarios.

In EVE sensitivity simulations, the present values of the Group’s cash flows are computed, with the focus on changes in EVE under different interest rate scenarios. This economic perspective measures interest rate risks across the full maturity profile of the balance sheet, including off-balance sheet items.

Stress testing is also performed regularly to determine the adequacy of the Group’s capital in meeting the impact of extreme interest rate movements on its balance sheet. Such tests are also performed to provide early warnings of potential extreme losses, facilitating the proactive management of interest rate risks in an environment of rapid financial market changes.

Liquidity risk is defined as the risk to the Group’s earnings or capital from its inability to meet its financial obligations as they fall due. Liquidity risk arises from the general funding of the Group’s banking activities and in the management of its assets and liabilities, including off-balance sheet items. The Group maintains sufficient liquidity to fund its day-to-day operations, meet deposit withdrawals and loan disbursements, participation in new investments, and repayment of borrowings. Hence, liquidity is managed in a manner to address known as well as unanticipated cash funding needs.

Liquidity risk is managed in accordance with a framework of policies, controls and limits approved by ALCO. These policies, controls and limits ensure that the Group monitors and manages liquidity risk in a manner that ensures sufficient sources of funds are available over a range of market conditions. These include minimising excessive funding concentrations by diversifying the sources and terms of funding as well as maintaining a portfolio of high quality and marketable debt securities.

The distribution of deposits is managed actively to ensure a balance between cost effectiveness, continued accessibility to funds, and diversification of funding sources. Important factors in ensuring liquidity are competitive pricing, proactive management of the Group’s ‘core deposits’ and the maintenance of customers’ confidence. ‘Core deposits’ are generally stable non-bank deposits, such as current accounts, savings accounts and fixed deposits. The Group monitors the stability of its ‘core deposits’ by analysing their volatility over time.

Aligning with the regulatory liquidity risk management framework, liquidity risk is measured and managed on a projected cash flow basis. The Group is monitored under ’business as usual’, ’bank-specific crisis’ and ’general market crisis’ scenarios. Behavioural modelling is carried out regularly to ensure that the cash flow requirements for ‘business as usual’ and crisis scenarios are realistic. Cash flow mismatch limits are established to limit the Group’s liquidity exposure. The Group also employs liquidity early warning indicators and trigger points to signal possible contingency situations.

Liquidity contingency funding plans are in place to identify a liquidity crisis through early warning indicators, Crisis escalation processes and various strategies including funding and communication strategies have been developed to minimise the impact of a liquidity crunch.

Overseas banking branches and subsidiaries are required to comply with their local regulatory liquidity requirements. In the event of liquidity crisis when they are unable to source sufficient funds for their operational requirements, the Group’s Head Office in Singapore would meet such requirements.

For major foreign currencies, the Group practises pool funding where regional branches and subsidiaries clear their placement and funding requirements with Head Office. This practice improves the efficiency of the Group’s deployment of funds. Behavioural modelling is carried out based on industry-approved methodologies and reviewed regularly. Loans and deposits which do not have maturity dates, and fixed deposits which are rolled over frequently, are generally estimated based on their past statistics or trends. There may be some differences in the assumptions across geographical locations due to variation in local conditions. Other balance sheet items like credit cards are generally estimated based on the behavioural patterns of customers.